cm lecture 2

8/14/2019 CM Lecture 2

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Credit ManagementThe Credit Initiation

Learning Objective

Take Risks but Calculated!!!

Presented By:

Asif Naqvi

Lecture # 2


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Credit Initiation

Target Market planning is the most important aspect of theCredit Initiation.

Target Market refers to business discipline & selectivity.

The Target Market (TM) process follows the formulation of theoverall business strategy for the Bank.

Identifying business potential, defining desirable opportunitiesand adhering to resultant marketing objectives.

TM identifies the acceptable and desirable profile of customersand the products to be offered.

Defines Risks Acceptance Criteria (RACs)


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The Factors Affecting the Target Market SelectionThe Factors Affecting the Target Market Selection

Political and Macroeconomic Framework Analysis:

An understanding and analysis of the macro environment is

necessary to decide on the overall growth strategy, balance

sheet/earnings targets, risk tolerance, and resource requirement

planning for each business group/sub-group in the domestic

network and each country in the International Division.

Political Structure:

Form of government

Key political forces/influencers Expected political changes and effect on economy/banking

sector


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Demographic and Economic Data:

Area, population, population density, rural and urban population

mix, literacy rate, GNP, GDP, GDP per capita, balance of trade,

balance of payments, forex reserves, foreign debt, domestic

debt, savings rate, inflation rate, etc.

Economic Policy:

Role of the state

Key features of fiscal policy

Key features of monetary policy Expected changes and their projected effects


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Legal Environment:

Level of sophistication

Degree of independence

Enforceability of security/collateral

Financial Services Industry:

Market size and level of sophistication

Market segmentation

Banks existing strategy and product offering in the market

Segments that the Bank is targeting

Identification of key players in those segments

SWOT analysis


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Identification of Target Industries/Sectors:

Begin with an evaluation of the economy of the country as a whole:

What is the structure of the economy? Which sectors of the

economy (agriculture, manufacturing, service, mining, etc.) are

major contributors to the economy?

What are the priorities of the government?

(in Pakistan, for instance the five year plans, the AnnualDevelopment Program, the annual budget document and, the

SBP Annual Report, etc., are useful sources of data)

What are the growth trends, and sources of growth?


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Industry Prioritization:

Determine which industries are a priority, based on:

Strategic importance to the country (export based, import

substitution, etc.)

Amount spent on acquiring products/services of the type that

the Bank offers

Credit quality and industry stability

Determine which industries are excluded


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Risk Acceptance Criteria (RACs)

RACs represent the minimum conditions under which the Bankis prepared to enter into transactions bearing an element of

credit risk.

RACs are the standard terms and conditions that would be

expected (keeping in view the environment and competition) indealing with each Risk Level within the TM

RACs should address eligible products, credit appetite, tenor,

security, support, documentation, covenants, pricing, etc., for

each type of client within the overall context of the industry

Annexure: Sample RACs


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Credit Risk Evaluation: 3 CsCredit Risk Evaluation: 3 Cs


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Credit Evaluation & Risk AssessmentCredit Evaluation & Risk Assessment

The 3 Cs of the Credit:

Character

Capacity

Collateral

Risk Assessment:

Business Risk

Management Risk

Product Line

Critical Success Factors

Risk Based Pricing.


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Credit Risk Evaluation

Credit Risk Assessment depends on bothCredit Risk Assessment depends on both

Qualitative & Quantitative Analysis.Qualitative & Quantitative Analysis.

Quantitative Analysis includes :Quantitative Analysis includes :

Balance Sheet AnalysisBalance Sheet Analysis

Income Statement AnalysisIncome Statement Analysis

Cash Flows AnalysisCash Flows Analysis

Analysis of Changes in EquityAnalysis of Changes in Equity

Future Sales ForecastingFuture Sales Forecasting

Sensitivity AnalysisSensitivity Analysis

Stress TestingStress Testing


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Credit Risk Evaluation

QualitativeQualitativeAnalysis includes :Analysis includes :

Nature of the companyNature of the company

Study the laws governing the company and theStudy the laws governing the company and thesectorsector

Market Share of the CompanyMarket Share of the Company

Management Depth/AssessmentManagement Depth/Assessment

Life of Plant & equipmentLife of Plant & equipment

Last BMR & Future PlansLast BMR & Future Plans

Credit Worthiness ReportsCredit Worthiness Reports

Market CheckingsMarket Checkings

Critical Success FactorsCritical Success Factors

Quantifying theQuantifying the Risk using Qualitative FactorsRisk using Qualitative Factors


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QualitativeQualitativeAnalysis Industry AnalysisAnalysis Industry AnalysisStructure of Industry:Structure of Industry:

Size and profitabilitySize and profitability

Quantify industry size, and profitability. Identify profit drivers.Quantify industry size, and profitability. Identify profit drivers.This, together with the financial profiles of key competitorsThis, together with the financial profiles of key competitorswould assist in identifying the winners and losers in thewould assist in identifying the winners and losers in theindustry:industry:

% of GDP% of GDP

% of revenues generated from local sales and from exports% of revenues generated from local sales and from exports

last 3 years growth in revenues, % due to increase in pricelast 3 years growth in revenues, % due to increase in priceand % due to growth in unit sales; sources of increases andand % due to growth in unit sales; sources of increases andexpectations for both for the next 12 monthsexpectations for both for the next 12 months

recent industry operating profit, sources of these profits andrecent industry operating profit, sources of these profits andexpectations for the next 12 monthsexpectations for the next 12 months


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QualitativeQualitativeAnalysis IndustryAnalysis Industry

AnalysisAnalysis

Maturity:Maturity: Identify the stage of industry life cycle in which the industry isIdentify the stage of industry life cycle in which the industry is

at the moment (embryonic, growth, mature, or declining)at the moment (embryonic, growth, mature, or declining)

Identify any recent change in degree of maturity and reasonsIdentify any recent change in degree of maturity and reasons

for changefor change

In as far as possible, give an estimate of how much longer theIn as far as possible, give an estimate of how much longer the

phase is expected to lastphase is expected to last

li i l i d


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AnalysisAnalysis

Degree of Industry Concentration / Fragmentation:Degree of Industry Concentration / Fragmentation:

Evaluate the level of concentration/fragmentation of theEvaluate the level of concentration/fragmentation of the

industry, and the buyers/suppliersindustry, and the buyers/suppliers

Identify where the maximum leverage lies (support this byIdentify where the maximum leverage lies (support this by

stating sale/purchase terms)stating sale/purchase terms)

Identify principal competitors, their market shares and recentIdentify principal competitors, their market shares and recent

changeschanges

Review economic / political / regulatory reasons for recentReview economic / political / regulatory reasons for recent

stability / change in degree of concentration and marketstability / change in degree of concentration and market

sharesshares

Q li i A l i I d


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AnalysisAnalysis

CyclicalityCyclicality::

How cyclical is the industry?How cyclical is the industry?

Does the industry have a positive or negative correlation withDoes the industry have a positive or negative correlation with

the cyclicality of the economy?the cyclicality of the economy?

Is its volatility higher/lower than that of the economy (i.e.,Is its volatility higher/lower than that of the economy (i.e.,

does it lead or lag the economy)?does it lead or lag the economy)?

Identify sources of cyclicality and industry efforts, if any, toIdentify sources of cyclicality and industry efforts, if any, to

reduce volatilityreduce volatility

Which part of the cycle is the industry in? How long is itWhich part of the cycle is the industry in? How long is it

expected to stay there?expected to stay there?

Quantify the effect of the cycle on industry revenues,Quantify the effect of the cycle on industry revenues,

operating profits, net operating cash flowoperating profits, net operating cash flow

li iQ lit ti l i dA l i I d t


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AnalysisAnalysisSources of Demand and Value Addition:Sources of Demand and Value Addition:

What are principal sources of demand for the industrysWhat are principal sources of demand for the industrysproducts / servicesproducts / services

Ascertain how much value is added by the industryAscertain how much value is added by the industry

What are the principal sources of value added (or the industryWhat are the principal sources of value added (or the industryvalue drivers) by the industryvalue drivers) by the industry

How much of the value added is retained by the industry (neHow much of the value added is retained by the industry (newentrants, suppliers, buyers, substitutes all compete for theentrants, suppliers, buyers, substitutes all compete for theadditional value that is created by an industry)additional value that is created by an industry)

How do the value drivers impact the structure of the industryHow do the value drivers impact the structure of the industry(in terms of profitability, bases of competition, concentration)?(in terms of profitability, bases of competition, concentration)?

What are the recent changes (and theWhat are the recent changes (and theeconomic/political/regulatory causes for the changes) in theseeconomic/political/regulatory causes for the changes) in thesesources and expectation for the next 12 monthssources and expectation for the next 12 months

Q li iQ lit ti A l i I dA l i I d t


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AnalysisAnalysis

Basis of Competition:Basis of Competition:

What are the bases of competition in the industry (examples:What are the bases of competition in the industry (examples:

product quality, distribution, sales terms, technology, price,product quality, distribution, sales terms, technology, price,

advertising/brand equity, after sales service, etc.)advertising/brand equity, after sales service, etc.)

How have the bases of competition changed: In the differentHow have the bases of competition changed: In the different

phases of the business cycle? Along the industrys life cycle?phases of the business cycle? Along the industrys life cycle?

With changes in technology? What is the expected futureWith changes in technology? What is the expected future

trend?trend?

What is the degree of product differentiation/commoditizationWhat is the degree of product differentiation/commoditization

in the industrys products/servicesin the industrys products/services

Barriers to entry & exit.Barriers to entry & exit.

Q lit tiQ lit ti A l i I d tA l i I d t


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AnalysisAnalysis

Government Support for Industry:Government Support for Industry: What are the sources (if any) of government support?What are the sources (if any) of government support?

protective tariffs, import quotas, licensing, etc.protective tariffs, import quotas, licensing, etc.

guaranteed access to credit facilities or provision oguaranteed access to credit facilities or provision osubsidized credit facilities, access to foreign exchangesubsidized credit facilities, access to foreign exchange

fiscal/tax policies regarding the industryfiscal/tax policies regarding the industry

What is their impact on industry revenues, profitability,What is their impact on industry revenues, profitability,operating cash flow?operating cash flow?

State recent rends and expectations (with reasons supportingState recent rends and expectations (with reasons supportingthe same) for next 12 months on sources of governmenthe same) for next 12 months on sources of government

supportsupport


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QualitativeQualitativeAnalysis ManagementAnalysis Management

The House is Open to Any Number of QuestionsThe House is Open to Any Number of Questions


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The House is Open to Any Number of QuestionsThe House is Open to Any Number of Questions

ThanksThanks

cm lecture 2

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